What will China do when faced with slowed growth
Beijing's new self-sustaining growth strategy must balance the stabilization of highly indebted sectors, such as real estate. Analysis by Paul Smillie, Senior Credit Analyst, Lin Jing Leong, Senior Sovereign Debt Analyst, Emerging Asia and Justin Ong, Senior Research Analyst, Asia Corporate Debt at Columbia Threadneedle Investment
The decision taken by Beijing in July to allow after-school services companies to carry out key aspects of their business on a nonprofit basis only might have seemed somewhat bizarre to Western investors.
The measure, however, was not only aimed at easing the growing burden of education for families under the "common prosperity" program. What many have not realized is that the measure also aimed at strengthening the spending power of the middle classes so that they could buy more Chinese products and reduce the economy's reliance on exports.
In 2021, China has reserved many surprises for us. Last but not least, its expansion slowed down more than expected. In our view, due to political reforms, credit crunches and blackouts, GDP growth should close the year at 7.5-8%, then slow further and drop to less than 5% in the first half of 2022. surprising, however, were the political reforms.
Beijing took advantage of the high growth rate in early 2021 to put the economy in order, which is commendable. Looking ahead, the Chinese authorities are called upon to pursue a delicate economic balance: keeping unemployment below the critical level of 5.5%, while continuing the credit crunch in highly indebted sectors such as real estate, local government and state-owned enterprises. Meanwhile, Beijing is seeking to stimulate domestic consumption and reduce dependence on the outside world – in terms of both exports and foreign investment – in a period of continuing trade tensions with the United States.
While pursuing these strategic goals – financial stability, social stability and self-sustaining growth – China will aim to implement a more targeted financial stimulus than in the past. Although credit will remain unchanged in real terms until the end of 2021, with growth in our view of around 11%, the reallocation towards priority sectors is more important: manufacturing with high added value, green energy and small and medium-sized enterprises. . Since joining the World Trade Organization (WTO) twenty years ago in 2001, China has produced low-cost items for export around the world. However, with the deterioration of international relations, the emphasis has shifted to protecting supply chains and the economy. Over the next decade, China will start producing for its own population.
How will it convince the middle classes to buy Chinese products? It is essential to remember that the average Chinese citizen spends his life saving for three things: buying a house, educating their children, and health care. Therefore, lowering education costs and cutting house prices play an important role in China's refocusing on the domestic economy.
The asset quality problem that plagues the financial system
The stabilization of the real estate sector affects the quality of the banking sector's assets. Everyone is aware of the difficulties Evergrande, one of the country's largest real estate developers, is facing in honoring his debts, but in reality the problems in the real estate sector are much greater. Total developer debt of RMB 20 trillion (US $ 3 trillion) corresponds to about 10% of total corporate debt or about 20% of nominal GDP.
Chinese small and medium-sized banks, which in 2020 made the main contribution to credit expansion to combat the pandemic, are the most exposed to the real estate sector. While the five largest banks are well capitalized and have grown in an orderly fashion, judging by Western standards about half of the smaller banks are technically insolvent. Since the global financial crisis, the assets of the "Big Five" have risen from 110% to 135% of GDP, while that of the smaller banks has jumped from 90% to 190%.
Nonetheless, China is aware of the problem and has the resources to solve it. A financial crisis seems unlikely given the absence of an obvious channel of contagion to global financial markets: Chinese banks finance themselves domestically and the People's Bank of China (PBoC) has a powerful arsenal of tools to use in case of financing problems. Despite the presence of potential internal and external catalysts that could trigger a funding freeze, none of them could materialize without a loss of confidence in the system, which seems unlikely.
Weakening of sentiment in the stock market
The misfortunes of the real estate sector, in competition with the regulatory changes regarding Internet and e-commerce companies, weighed on sentiment in the stock market. Since the beginning of 2021, real estate developers (excluding the Evergrande group) have defaulted on approximately $ 12.7 billion of debt, equal to 4.7% of the Chinese high yield segment.
To cool the sector, in 2020 Beijing launched the "three red lines" policy, which aims to limit the debt of developers using three balance sheet indicators: the ratio of liabilities to assets, the ratio of net debt to equity net and the ratio of cash to short-term loans. If a developer does not meet all three of the above criteria, they cannot issue any more debt, and therefore cannot refinance and grow. To regulate the sale of land, the government introduced centralized auctions in 22 cities; so far, however, the results have been mixed as land auction prices remain high in some areas.
As for Internet and e-commerce businesses, after years of rapid growth, the sector is affected by a series of regulatory changes aimed at addressing the same issues of data privacy and monopolistic trends observed in the West. However, in the case of China, which has a top-down economy, stemming the power of these companies is much easier. Investor sentiment weakened in July after Chinese regulators launched a data security investigation into China's leading ride hailing app, Didi Chuxing, just days after it went public in New York.
Opportunities deriving from impulse factors
However, despite the regulatory surprises of 2021 and slowing economic growth, opportunities remain to invest in China's broad equity universe. Despite the regulatory hurdles associated with e-commerce, common prosperity, and after-school services, Beijing's policies are encouraging in many other areas.
These include manufacturing with high added value and green energy, for example in the electric vehicle sector. The strategic objectives that emerged from 2021, instead of acting as a brake, will give a strong impetus to these sectors.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/cosa-fara-la-cina-alle-prese-con-una-crescita-rallentata/ on Sat, 04 Dec 2021 06:53:32 +0000.